Natural resource funds have fared poorly over the past decade, as the
global economy continues to recover from the monetary crisis and consequent
recession. The Natural Resources Equity category as a whole has turned in an average annualized negative
rate of return over the period. Some funds, of course, with able management, consistently
buck the trend. One such is the FundGrade A+ Award-winning
Fidelity Global Natural Resources Fund, which has managed to pull off category-beating positive returns over the
same period.

The average annual compounded rate of return for Natural Resources Equity
category for the 10-year period through July 31, 2017 was a miserable -5.1%.
Still, there are signs of life in the sector – returns from resource funds
averaged 1.6% in July, second only to the one-month return posted by the
Greater China Equity category.

Darren Lekkerkerker and
Joe Overdevest, co-managers of the
Fidelity Global Natural Resources Fund, continue to choose commodities and companies with care, while keeping a
close eye on the macro picture – a strategy that has consistently put them
at the top of the performance listings for the category, with an average
annual compounded rate of return of 3.2% over the past 10 years and 5.7%
over the past five years, as at July 31.

“Commodities was the place to be during the period from 2003 to 2011,” says
Lekkerkerker (who handles materials, while Overdevest handles energy
stocks, in a 50/50 portfolio split). “The fundamentals were very
attractive, but since then, performance has been mixed. There have been
bull markets in some individual commodities, but for example, the period
from 2013 through 2016 was particularly bad for mining stocks, both base
metals and gold. Some companies fell more than 50%, although others doubled
in value during the same period.”

“The supply and demand picture can vary quite dramatically for different
commodities,” Lekkerkerker adds. “We favor zinc and copper; zinc because
supply and demand is very tight, and copper because supplies are getting
tighter and could move to a deficit in two or three years’ time – not many
new mines are being created. We’re bullish on gold too, but cautious. Gold
has positive portfolio characteristics – it goes up when other things go
down – but we’re worried that rising interest rates could drive prices
down.”

“Timber is up a lot because of growing demand from a strong U.S. housing
market, as well as the current softwood lumber negotiations with Canada,”
says Lekkerkerker. “We also have a big position in packaging companies,
which have benefitted from the fall in commodity and oil prices.”

As for energy-related stocks, Overdevest notes that here too, performance
can vary dramatically among players. “You have refiners, integrateds,
services – they’re all different,” he says. “Overall, though, the outlook
for the energy sector is not great, but it’s okay. Supply and demand are
pretty well balanced now, and world growth is doing okay. The biggest
change has been increased shale oil drilling in the U.S., which has led to
lower costs. The production cost of oil from the tar sands is US$100 a
barrel, but in Texas it now costs $45 a barrel, and that has driven down
commodity prices.”

How to make sense of all these variations? “We have a bottom-up focus, but
we also look at supply and demand for each individual commodity, as well as
overall macro demand,” says Overdevest. “We’ll buy large, medium or small
caps, both growth and value-oriented, and the way we choose is based on the
answers to four questions:

1.
Is the commodity attractive? What do supply and demand look like?

2.
Is this a good business? Does it have a good competitive position, strong
cash flow, and high return on investment?

3.
Is the management team aligned with us? Have they done a good job in the
past, and do they have the same goals as us, that will benefit our
shareholders?

4.
Is the valuation attractive? Sometimes good news has already been priced
into stocks, other times it’s ignored.”

The strategy has led to picks like Toronto-based
First Quantum Minerals Ltd. (TSX: FM). “This is a well-managed copper miner with high-quality assets, and they
are building a new mine in Panama that will almost double their production
and exponentially increase their profits, yet the stock price has not done
very well,” says Lekkerkerker. “They’re up just 2% on the year to date,
versus 12% up to as much as 45% for its peers.

Another favorite is Dallas, Texas-based
Texas Pacific Land Trust (NYSE: TPL). “The history behind this company is that when they were building the
railroad in Texas, the builders were given land rights in perpetuity,
including all drilling rights, and some of the lands were located right in
the Permian Basin,” says Overdevest. “Now they receive royalties in
perpetuity but have no drilling or field costs. They’re just landowners,
and have free cash flow of 3%-4%, with which they buy back stock and issue
dividends.”

Olev Edur is an experienced financial and business journalist and a frequent
contributor to the Fund Library.

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